Now that the titans of Wall Street have moved toward extinction, some hedge funds are interested in taking over the lucrative
deals those firms are no longer able to shepherd.
Only a year ago, several investment banks were competing to perform a variety of tasks in the capital markets, including
underwriting, lending, public offerings, buyouts, brokering and advisory services. But now Bear Stearns and Lehman
Brothers are gone, and Merrill Lynch's unexpectedly large losses have sent shocks though its new owner, Bank of
America (BAC Quote - Cramer on BAC - Stock Picks).
Goldman Sachs (GS Quote - Cramer on GS - Stock Picks) and Morgan Stanley (MS Quote - Cramer on MS - Stock Picks)
are less able to engage in big deals and risky trades because of their transfer to bank-holding companies -- a move they were
forced to make in order to receive funds from the government to stay afloat.
The financial industry at large has been holding tightly on to capital that once greased the wheels of the economy, freezing the
credit markets and impeding consolidation across just about every industry.
The number of leveraged M&A deals dropped by half last year, according to Dealogic, while the value of such pacts dropped
54%. Of the top 10 leveraged deals announced from the start of 2008, only three of them came after the Lehman bankruptcy,
which exacerbated the credit crisis.
Pfizer's (PFE Quote - Cramer on PFE - Stock Picks) announcement of a $68 billion move to acquire Wyeth (WYE Quote Cramer on WYE - Stock Picks) last week may have seemed like the permafrost was finally thawing, but the deal only occurred
because Pfizer has top-notch credit ratings and the banks involved secured stringent and lucrative terms for their $22.5 billion
loan.
If nothing else, the Pfizer-Wyeth combination shows that corporate America is starved enough for capital to pay moderately
high interest rates and put more skin in the game just to get deals done. As a result, some hedge funds are exploring whether
they might step in to snatch the low-hanging fruit that the former giants are less able to pursue.
Igor Lotsvin, co-founder of the San Francisco-based hedge fund Soma Asset Management, says the dislocation of Wall
Street's top names has provided "tons of opportunities" in the investment banking arena.
"That's certainly the role we're looking at ourselves," says Lotsvin. "We're getting reverse inquiries and raising capital, slowly,
but steadily. Our mandate is pretty broad, and we've traditionally been a long-short equity investor, but now we're seeing
other huge opportunities in lending or in the credit markets, now that the world of investment banking has been decimated."
Lotsvin says he's not alone. He predicts that in six months, "you'll probably see advisers in the business very different from the
white-shoe firms you've always seen in the past."
Of course, that hasn't happened yet. Familiar names like Goldman, Merrill, Morgan Stanley, Bank of America, Citigroup (C
Quote - Cramer on C - Stock Picks), JPMorgan Chase (JPM Quote - Cramer on JPM - Stock Picks) and foreign banks like
Barclays (BCS Quote - Cramer on BCS - Stock Picks), UBS (UBS Quote - Cramer on UBS - Stock Picks), RBS (RBS Quote Cramer on RBS - Stock Picks), Credit Suisse (CS Quote - Cramer on CS - Stock Picks) and Deutsche Bank (DB Quote Cramer on DB - Stock Picks) are still the most prominent names for big buyouts and advisory services.
But it wouldn't be the first time that hedge fund industry changed course and rebranded itself by entering strange new
territory.
Ezra Zask, who worked in hedge funds for two decades and is now a director at the consulting firm LECG, notes that the
industry began blurring the lines between hedge funds and private equity years ago by acquiring large, longer-term ownership
stakes in companies. Now, prominent players like Fortress (FIG Quote - Cramer on FIG - Stock Picks), Blackstone (BX Quote

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- Cramer on BX - Stock Picks), Citadel and Cerberus offer investments in both the hedge fund and private equity space, or a
hybrid of both.
Perrie Weiner, international co-chair of DLA Piper's securities litigation practice, says some big hedge funds were "already
were starting to overtake many of the investment banks" before the financial crisis heated up. Weiner, who has several hedge
fund clients, attributes that to the "enormous resources" at their disposal, and hedge funds' ability to move more quickly to
close deals than their older competitors.
Now, he says, "you're going to see hedge funds leading the way, because they're the first to dive into the market, and they
have lots of cash sitting on the sidelines."
However, while hedge funds are not averse to infringing on the territory of other institutions, their ability to dominate the
investment-banking space is not entirely a question of will. After an unexpectedly weak performance in 2008, hedge funds are
buckling under the pressure of client withdrawals. They are also facing a crisis of confidence from a slew of Ponzi schemes
that have been uncovered, namely the Bernard Madoff scandal.
Pierre Villeneuve, managing director of the hedge fund Mapleridge Capital, says his industry will have to "rebuild the trust that
has been shattered" before entering new lines of business in this challenging environment.
"For hedge funds to move into Wall Street's turf will require a lot effort," he says in an e-mail message. He later adds that
they also "do not have access to the credit markets -- no one has -- to facilitate the type of business that dominated Wall
Street in recent years."
Another prominent barrier is the changing regulatory landscape, with President Barack Obama and other leaders promising to
monitor hedge funds more closely. Details remain sparse, but it's unclear what the largely unregulated industry will and will
not be able to do once a regulatory plan is unveiled.
Nadia Papagiannis, a hedge fund analyst at Morningstar, also points out that few funds have the scale and talent to support
the type of business that a Goldman or Merrill could have in its heyday. Even massive firms like Renaissance or Citadel are
"also really hurting," she says. Consolidation may weed out weaker players and create larger, stronger ones, but Papagiannis
doesn't expect a massive change in the hedge fund business model.
"I don't really think they're going to be the next titans of Wall Street," says Papagiannis. "A lot of these big banks either
seeded hedge funds or were investors in hedge funds. It's a symbiotic relationship. You can't have one without the other."
Still, the fall of the titans has created a dearth of investment banking services in what many still recall as a booming, profitable
industry. Lee Giovannetti, CEO of Consulting Services Group, attended the hedge fund industry's GAIM conference in Miami
recently, and asserts that "somebody is going to have to step in and take their place."
While Giovannetti calls hedge funds "a very likely candidate," he is careful to note "it's still very early to tell."

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